PBOC Introduces New Tool to Manage Liquidity and Interest Rates

On Monday, China’s central bank, the People’s Bank of China (PBOC), introduced a new policy tool designed to manage liquidity and interest rates within the banking system more effectively. The instrument involves temporary bond repurchase agreements and reverse repos, setting interest rates to influence short-term borrowing costs.

Analysts suggest that this move could establish a new interest rate corridor, with the seven-day reverse repo rate serving as a benchmark for short-term interest rates. PBOC Governor Pan Gongsheng previously indicated that the seven-day rate functioned similarly to a key policy rate.

The temporary repos and reverse repos will be short-term loans with a one-day maturity. The PBOC will decide whether to conduct repos or reverse repos based on market conditions. Interest rates for these agreements are set at 20 basis points below and 50 basis points above the seven-day reverse repo rate, translating to 1.6% and 2.3% respectively.

This measure provides the PBOC with the flexibility to fine-tune liquidity conditions, either by injecting cash through reverse repos or draining excess funds through repos. The asymmetrical interest rates are intended to deter excessive borrowing and may evolve into a formal policy tool, given the higher rate for borrowing compared to lending.

Analysts predict that the PBOC will use these temporary operations strategically, especially at month-ends or quarter-ends, when liquidity management is more critical. While the immediate response in the Chinese bond market was muted, with only a slight increase in yields, some analysts view this PBOC initiative as a signal of potential liquidity tightening.

This move comes amid recent PBOC comments about the possibility of tapping a large pool of bonds for sale at any time, underscoring the central bank’s proactive stance in managing market conditions.